Friday, 23 January 2009

Demography and the current financial crisis

Nick Silver over at the IEA blog has a posting on Demography and the financial crisis. He notes that Martin Wolf, the Financial Times' chief economics commentator has put forward an explanation for the cause of the current financial crisis. Briefly, Wolf argues that 'the savers' of the world, China, Germany and Japan et al produce more than they consume. This excess production gets exported to 'the spenders' who are lend by the USA along with other countries such as the UK and Spain. The resultant excess savings are exported by the savers to the spenders to fund the consumption, which has resulted in asset bubbles and huge debts amongst the spenders. Wolf goes on to suggest that 'the savers' need to reduce their "chronically high" savings rates so that they no longer run large current account surpluses.

Silver wants to offer an alternative view. He writes:
It is true that the UK and USA, for example, have younger populations than Germany and Japan. However, they still have ageing populations. Yet gross national savings rates in both countries are approximately 13% of GDP (compared with 27% and 25% in Japan and Germany respectively (IMF data)). The demographics therefore suggest that it is the USA and UK that have the serious problem - chronically low savings rates.

What might happen if the spenders’ savings were in line with their demographic situation? They would have a lower propensity to borrow and spend, so would have a lower demand for the savers’ capital. The savers would still export capital to the spenders, due to the age differential between the populations, but in far smaller quantities. Saving countries would therefore export more capital to younger countries, in regions such as South Asia, the Middle East and South America. Local investments would also be relatively more attractive, as would increased consumption.

Faced with the ‘credit crunch’, the mantra of most economists and politicians has been to encourage consumers and companies to borrow and spend. And if they stop spending, governments are acting as spenders of last resort.

This is akin to giving a heroin addict more heroin to stop the pain of withdrawal - it might stop the immediate pain but as a treatment it’s totally self defeating. The real problem is that certain economies, notably the UK and USA, are structured in such a way that they are heavily reliant on ever increasing borrowing backed by over-inflated asset values - when this stops, growth and employment collapse. It is this that has to change.
Silver's blog is based on work done under the IEA Empowerment Through Savings Programme.

1 comment:

Matt Nolan said...

Indeed, part of the current crisis does related to a structural shift. I felt the same way when I wrote my last dom post article:

If reduced consumption is stemming solely from higher equilibrium interest rates there is nothing the government can do. The argument then is - is there any other "shocks" that have occurred that could have been exacerbated by a market failure.